Option Investor
Market Wrap

Dow 10K, S&P 1100, Naz 1900 Fall

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     05-10-2004            High     Low     Volume Advance/Decline
DJIA     9990.02 -127.32 10116.28  9932.74 2.29 bln    317/2634
NASDAQ   1896.07 - 21.89  1907.98  1880.32 1.86 bln    697/2443
S&P 100   532.68 -  4.67   537.35   528.74   Totals   1014/5077
S&P 500  1087.12 - 11.58  1098.70  1079.63 
RUS 2000  537.86 - 10.70   548.56   533.51
DJ TRANS 2810.01 - 36.17  2842.53  2789.03
VIX        19.77 +  1.64    20.20    18.99
VXO        19.74 +  0.67    21.29    19.43
VXN        27.91 +  2.41    28.15    26.75
Total Volume 4,800M
Total UpVol    953M
Total DnVol  3,768M
52wk Highs      32
52wk Lows     1181
TRIN          0.84
PUT/CALL      1.28

The selling began after the cash close on Friday and resumed in the futures last night. The markets gapped lower at the open, ran to their lows just before noon and then bounced, moving sideways in a range for the duration of the session. Volatility was sharply higher as premium increased in the options market, while bonds traded mixed to lower. Today's close was the lowest close of the year for the indices.

Despite the 1%+ losses on the Dow, SPX and Nasdaq, bellwethers such as GE and MSFT finished in the green. Whether this was a legitimate heads-up on a market turn to come, or mere tape- painting by mutual funds and the Fed's 23 dealers using the 6B in repo money added today, remains to be seen. The intraday indices were oversold and trying to turn up off the lows at the close, and whether it's a deadcat bounce or a 30 minute cycle upphase, a bounce is due in all the intraday timeframes. The trouble for bulls is not the intraday cycles, however, but rather the longer ones, the daily, weekly and monthly, all of which are in synchronous downphases.

Daily Dow Chart

The Dow violated trendline support at 10180 and never looked back, falling below confluence and psychological support at 10K and closing below it. There's confluence support from 9930 to 9800 accumulated over the years, and I don't expect the bears to have an easy go of further downside in that range. But price never reacts to support the same way twice, at least not predictably, and I'm not inclined to blindly trust these levels for bullish trades. The longer cycles remain firmly down, and the daily shows no sign of having bottomed yet. If, however, a meaningful bounce can launch off the intraday cycles (not shown), as those shorter oscillators are suggesting, and the move is sufficient to turn the daily cycles up from here, there will be a bullish oscillator divergence and the move should have good upside force.

Monthly Dow Chart

I've zoomed out to a three year monthly view of the Dow to show the 3-crows bearish pattern as well as the sell signal on the 10 month stochastic. The issue for me on this monthly timeframe is whether the bulls can put together a sufficiently strong daily cycle upphase to retest either broken bear wedge apex or the descending trendline at 10650ish. If this is a significant top forming, a "return to the scene of the crime" distribution rally would not be out of the ordinary. However, for the moment, the combination of the daily, weekly (not shown) and monthly downphases is producing extreme weakness, and for the moment the trend on these longer timeframes remains down.

Daily Nasdaq Chart

The Nasdaq closed at 1896. It would be premature to conclude that 1900 is history, particularly given the potential for a bullish oscillator divergence on the daily chart. Support came at a low of 1880, but the selling was sufficiently constant to prevent any of the clear, directional moonshots that we've come to expect since 2003 on tests of critical support. Below 1880, there's support at 1845. As with the Dow, a strong intraday upphase based on the 30 and 60 minute charts, due to commence imminently, could set up a strong launch on the daily. A failure to bounce tomorrow would constitute a "crash" in the 30 minute timeframe as the market trends lower. Given the weakness in the daily, weekly and monthly oscillators, traders trying to play that countertrend bounce need to be close with their stops and nimble, as the afternoon chop today showed us.

Monthly Nasdaq Chart

The monthly Nasdaq chart is more difficult to read because of the higher peak in spring 2000. But again, the monthly cycles are rolling over. A strong daily cycle upphase could whip the price back up to the year highs as a distribution top, but such could also set up a reverse head and shoulders below 2100 or a simple bull flag breakout. I cite these setups despite the sell signal on the 10 month stochastic and the anticipated signal on the Macd to show both sides of the coin. Bulls see this move as a correction of the 2003 rally, while bears see the 2003 rally as a correction of the 2000-2002 decline. While the intraday cycles want a bounce tomorrow, the top of that bounce is going to determine a lot for the Dow and Nasdaq. A lower high suggests a weak daily cycle, which suggests that the weekly is also bearish, which suggests that the monthly is indeed in a new bearish phase. A higher high could launch a daily cycle rally that could challenge the breakdown, if not the year highs.

Weekly chart of the OEX:VXO ratio

Another perspective on the current downleg is by viewing the ratio of the S&P-100, the OEX, to its corresponding volatility index, the VXO (the old VIX). By measuring the OEX:VXO ratio, we can chart the OEX' price trend relative to option volatility. As we know, option volatility tends to rise when price declines, and vice versa. By placing this relationship on a single chart, we can view the general trend, which here is in a clear downphase on the weekly chart. We see that the OEX:VXO is at a confluence level at current levels, which should provide support for the OEX/ resistance for the VXO. Next support is in the 18 area.

Weekly chart of the QQQ:QQV ratio

The QQQ:$QQV ratio is also locked in a weekly downtrend and also in a support zone. It's worth noting, as with the OEX:VXO, that this ratio has not reached these levels of oscillator weakness since 2002, indicating that the force of the drop in price/increase in volatility exceeds any we've seen in 2 years.

Weekly chart of NYSE New highs-new lows

Here's one last perspective on the recent action. The chart of new highs minus new lows for the NYSE is a simple snapshot of breadth. The internal damage appears to be far worse than the price declines would otherwise indicate.

It was a quiet news day overall, with no major economic news to report and the markets trading on their own. Before the bell, it was announced that C would incur a $1.6B charge to settle litigation with Worldcom shareholders without admission of liability. C closed lower by 2.8% at 45.41. Combined with general rate-hike-related malaise, banks were weak, with the $BKX closing lower by 1.6%.

President Bush made a statement at the Pentagon after receiving a briefing from his national security team, coming out strongly in defense of Secretary of Defense Rumsfeld: "You are courageously leading our nation in the war against terror, you are doing a superb job, you are a strong secretary of defense and our nation owes you a debt of gratitude." He warned that that there remain hardships and sacrifices to come, and that the US will continue to aggressively oppose militants in Iraq. The statement was no doubt in response to the fireworks from Rumsfeld's appearance before the Senate Armed Services Committee on Friday, but also came on the heels of a scathing editorial in The Army Times, a Gannett Co. Inc. (GCI) newspaper that reports on the U.S. military. The editorial asserted that both Rumsfeld and Joint Chiefs Chairman Myers are guilty of professional negligence in the affair.

Crude futures were weak and led the CRB lower, with the move being credited to news that Saudi Arabia said OPEC should raise its production quota by 1.5 million barrels per day. Saudi Arabian Oil Minister Ali al-Naimi said that OPEC should increase its production target by over 6% when it meets on June 3. "We [...] do not want to see prices rise to the level that they negatively affect the growth of the international economy or the demand for oil. It is apparent that demand, especially that of Asia, has and will continue to increase in the second half of this year."

The Federal Reserve fined one of its primary dealers, UBS, $100M for its business dealings with Cuba, Iran, Libya and Yugoslavia. The Fed's 3 page order asserted that "certain former officers and employees of UBS engaged in intentional acts aimed at concealing" bank transactions with these countries. UBS agreed to pay the fine without admitting to any of the allegations.

IBM announced new software for corporate desktops to provide open-source alternatives to Microsoft Office. The company said that the new server-managed software package would permit users to deploy business applications and data on desktops, laptops, and hand-held computers, and is designed to support Microsoft Windows, Unix, Linux and other operating systems with Mac support to be added later. Being a satisfied user of the free "OpenOffice" suite, I find it encouraging to see open source competition for this critical software space. I believe that end-users are the ultimate beneficiaries of competition, both in terms of price and quality.

XMSR was very weak throughout the session on news of its Friday filing for the resale of 10M shares owned by GM at a warrant strike price of $3.18 exercised in April 2004. XMSR finished lower by 6.05% at 21.62.

For tomorrow, I'm keeping an open mind. On the one hand, it would be reasonable to expect the oversold bounce mandated by the 60, 30 and short cycle oscillators. On the other hand, the internals look so awful and the daily, weekly and month stochastics are so uniformly bearish that if there were to be an intraday trending move or "crash" in the intraday cycles, it would not be surprising here. Bellwethers such as GE and MSFT were strong and finished green despite the broader market destruction, either because they were being used to prop the indices price-wise, or because funds and traders were loading up in anticipation of that short cycle bounce.

Crashes, even on the 30 and 60 minute timeframes, are less common events as oscillators tend not to trend in oversold or overbought. The odds favor a bounce here. If it doesn't occur, then bears need to be sufficiently nimble and flexible to let their stops take them out of it. Don't get caught the wrong side, whichever side that turns out to be.


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